It would be an understatement to say the federal government has been harsh on state-legal cannabis companies, whether by denying them federal tax deductions under the dreaded Internal Revenue Code Section 280E or threatening banks and lenders with legal action if they do business with companies in the industry.
While nearly all traditional business expense deductions are off limits for cannabis companies thanks to 280E, there have been some minor breakthroughs over the years—most notably, the Internal Revenue Code provision that allows cannabis producers and retailers to deduct the cost of goods sold when computing their federal income tax liability.
Cannabis operations, subjected to federal scorn for most of the past century, received an unexpected boost when most were deemed “essential” during the COVID-19 pandemic. In 2020, as part of the Coronavirus Aid, Relief, and Economic Security Act, the federal government created an employee retention tax credit that provides employers a credit of up to $10,000 per employee if their businesses were impacted in specified ways.
When workforce management company Würk and its partner ETaxBreaks dug into the details of the act, they discovered the credit was applicable for cannabis companies with fewer than 500 employees. Würk Chief Executive Officer Scott Kenyon called the program a groundbreaking tax credit on the federal level.
“As far as we’ve heard, this is the first [federal tax credit],” said Kenyon. “I think this is clearly the first one we have where the cannabis industry is not called out as an exception. So taking advantage of it is a big thing for our small and medium-sized businesses.”
Würk has helped cannabis businesses with payroll processing and other fintech services for the past five years, processing about $3 billion in payroll in 2020 alone. Kenyon believes the credit is a sign of things to come, and his company has been looking for more ways to help its clients find tax relief at the federal level. One of the areas he highlighted is research and development, which is open to interpretation, so to speak. “From what I’ve heard from other companies, they’re testing the boundaries,” he said. “So I’m sure there have been some creative [research-and-development] write-offs that probably skirt the line of what is possible.”
Compliance matters, too
As cannabis companies branch out across the United States, tax compliance is becoming a more complicated and expensive part of operating. Since cities and states have their own tax codes for retail, excise, and more, it’s becoming a dizzying exercise for companies to stay in compliance and stay alive. Of course, for fintech companies like Würk, it’s an opportunity to sell its expertise in the field.
“Companies will call and say, ‘I’ve got this challenge in New York,’ so that’s a different person than you talk to about your tax question or challenge in Michigan,” said Kenyon. “That makes it harder for my business to scale, but over time, as the industry continues to grow, it’s a great advantage to have. No one’s going to be able to come in and compete with me and the type of knowledge base that we have in all of these different states.”
While the pandemic-related employee tax credit might be seen as a hopeful sign, it’s really just a drop in the bucket for companies faced with state taxes as high as 30 percent to 40 percent. In the short history of state-legal cannabis, excessive taxation is the primary reason companies have struggled to survive and compete, and this is especially true for small and medium-sized operators.
Likewise, if the federal government genuinely wants to snuff out the black market—still alive and well and making it nearly impossible for licensed companies to thrive—the easiest way would be through offering more tax relief to legal businesses.
Encouraging growth and equity
Moreover, there are any number of areas where write-offs and other traditional benefits could encourage companies to increase employee and societal welfare. Despite an impressive amount of discussion and debate about social equity in the industry, people of color (POC) still have only a miniscule ownership stake in the industry. So how about a tax break for companies that institute meaningful social equity programs that lead to more POC ownership? And what about climate change? Massive indoor cultivation operations are putting an increasing amount of stress on power grids across the country, while outdoor growers are struggling to survive. How about shifting some of the colossal industrial agriculture subsidies to outdoor cultivators practicing responsible, regenerative farming?
In short, it would be a shame if the only glimmer of future tax relief for the industry were due to a virus everyone is looking forward to putting in the rearview mirror.